Microsoft and Eastman Kodak have reached a settlement that could take some political pressure off the software maker and its plans to launch the Windows XP operating system.

Kodak had accused Microsoft of unfairly designing Windows XP in the way it handles digital photos. The photo products maker said Windows XP limited consumer choice in the default application for manipulating photos and steered consumers to Microsoft's preferred online photo processors.

The companies' CEOs--Steve Ballmer from Microsoft and Daniel Carp of Kodak--resolved many of their major differences last week, although some issues remain, sources close to the companies said.

Beta testers of Windows XP, which is set for commercial launch this fall, dispute the legitimacy of Kodak's claims, however.

Kodak's criticism appears to have been quelled by Microsoft changing one dialog box affecting how Windows XP handles imaging devices, such as digital cameras and scanners. Kodak agreed that its software would not automatically become the default for any digital camera attached to a PC--including competitors'--and to publicly support Windows XP.

Kodak also plans to pull back some of the pressure it placed on Charles Schumer, a Democratic senator from New York, to question whether Windows XP's photo features are anti-competitive. The companies are expected to announce the resolution of their differences Monday.

"We are pleased to have worked together with Kodak to resolve any perceived issues regarding how Kodak's cameras and software work with Windows XP," said Jim Cullinan, Windows XP lead product manager. "Kodak is an important partner for Microsoft, and we welcome feedback from Kodak on ways to improve the digital photo experience in Windows XP.

Kodak spokesman Anthony Sanzio added Sunday morning: "We think this is a positive move by Microsoft. We're happy that our EasyShare cameras will work well with Windows XP. We look forward to moving ahead with Microsoft to (make) further improvements with the digital photography experience."

Before the changes, connecting a camera to Windows XP would bring up Microsoft's Scanner and Camera Wizard, which displayed a pull-down list of installed software capable of accessing the images on the device. Microsoft had not made allowances for camera makers to use their own software to connect with devices by default, although a person could choose a default program from the menu.

With the changes, rather than automatically bringing up Microsoft's wizard and pull-down menu of choices, connecting a camera will summon a single box of software choices capable of connecting to the camera.

"The Scanner and Camera Wizard will be clearly labeled as a Microsoft function, not a generic function," Sanzio said. "Microsoft has agreed finally to sign third-party picture protocol drivers, so that if a camera manufacturer wants to use the standard Windows implementation, they can, or they can use their own drivers for their own cameras."

The driver issue had in some ways been the most contentious issue between Microsoft and Kodak, with both sides accusing the other of trying to take control of all digital camera connections to a Windows XP personal computer.

Playing the political cards
Kodak's troubles with Windows XP have helped churn up the controversy building around the new operating system.

In late July, Schumer asked the Justice Department and 18 states to seek an injunction delaying Windows XP's scheduled Oct. 25 launch. Schumer largely attacked Windows XP technologies affecting AOL Time Warner and Kodak, both of which have headquarters in New York.

Schumer's call for trustbusters' action against Windows XP came the week after a Microsoft tour showing off photo and imaging features to the media and days before a New York event showcasing the enhancements. Kodak, which had been invited to participate in the event, took it as an opportunity to accuse Microsoft of using its Intel-based operating system monopoly to wrestle control of processing and sharing digital images.

Kodak is ready to pull back the concerns it raised with politicians about Windows XP's handling of digital photography and imaging, Sanzio said.

"We think Senator Schumer as well as other legislators were instrumental with helping us get where we are," he said. "Certainly we will let all of the legislators and all of the people involved with this know what the current situation is. We're pleased with where we are, but there is some more to do. We hope to do that in private with Microsoft."

Phil Singer, a spokesman for Schumer's office, said: "Microsoft has taken a big step in starting to resolve some of these issues, meaning going back to being more consumer-friendly. We still need to take a wait-and-see approach, but this is obviously a positive thing. I don't think it ends the issue."

The Kodak-Microsoft rift underscores photofinishing's shift away from print to combined print and digital and full digital services. Online photo-processing services, for example, allow consumers to use a digital camera to shoot pictures that can be printed by Kodak or one of its rivals and picked up at a local drug store.

Market researcher IDC predicts that retail kiosks will help satisfy consumers' growing demand for images printed instantly, and that the Internet will become "the backbone" for transferring images.

Digital devices captured 9.1 billion images last year, with that number expected to reach 29.5 billion in 2005, IDC concluded. Digital cameras will account for the bulk of digital images captured: 17.4 billion. Consumers will dominate the need for photofinishing services, accounting for 11.4 billion images printed compared with 4.2 billion for businesses in 2005, the market researcher concluded.

In a July report, Gartner analyst Andrew Johnson concluded that more consumers are interested in viewing and sharing images online than in getting the same output as film, which is driving a change in the business model for photo processing. The market researcher estimates that 8.9 million digital cameras will be sold this year, reaching 12.5 millions in 2005.

Kodak is aligned with Microsoft rival AOL Time Warner's America Online division, a partnership that could underscore some of the competitive reasons for the XP attacks. At the end of July, Kodak and America Online launched a new version of their You've Got Pictures service for viewing, sharing and storing photos online. To use the service, which costs around $9, consumers drop their film at a Kodak retailer, such as CVS pharmacy, for print and online processing.

The service is big business for both companies, with an America Online study finding 92 percent of online consumers interested in sharing photos online.

The You've Got Pictures service "is at the heart of a range of AOL initiatives," and it "is a key feature of AOL 7.0," the companies said in a July 31 press release. AOL 7.0, the next version of America Online's client software, is in beta testing.

Kodak also claimed that Microsoft wanted to take control of the digital imaging process, steering consumers to the software maker's preferred print-processing providers.

CNET News.com tested the photo features in two Windows XP release candidates--or near-final testing versions--using an Olympus Camedia C-3030 digital camera. Connecting the camera to a USB port summons Windows XP to install a software driver for connecting to the C-3030 and launches the operating system's Scanner and Camera Wizard.

The wizard allows for retrieval of photos from the camera and offers several additional options, such as ordering prints from a photofinishing Web site. Currently, only three choices are available: MSN, Fujicolor and Kodak.

While Kodak has accused Microsoft of favoring its preferred photo-developing providers, Kodak's is the only one of three processing options currently available. The other two services were not available during the test, while prints could have been ordered from Kodak.

"While our service is available in the Windows XP betas, we do not yet have definitive agreement around that," Sanzio said. "We are currently working with (Microsoft) to resolve that issue."

Windows XP beta testers praised how the new operating system handles imaging and questioned the validity of Kodak's complaints.

"I know when I put a CD in or a blank CD in a burner, it asks me what I want to do with it," said Jeff Patton, a Windows XP beta tester from Topeka, Kansas. "I think Microsoft is letting the consumer choose his or her favorite program to use, like with an audio CD."

Unlike earlier versions of Windows, accessing anything with digital content on it--camera, CD or DVD--brings up a dialog where the user chooses the program to view or play the content. There also is an option to set one program as the default.

Scott Galvin, a Windows user from Fort Collins, Colo., pointed out that users ultimately control what software is the default for handling digital imaging.

"With Windows XP, as well as the previous versions, users have always been able to install software that replaces the bundled software Microsoft includes," he said. "If Kodak wants to succeed, they'll need to offer incentives, whether it's low prices or more features."